In a televised address to the nation, President Bush said the new Department of Homeland Security will co-ordinate policy on everything from border security to processing intelligence reports.
It will take responsibility from more than 100 different agencies in what Mr Bush called the biggest shake-up of US government for 50 years.
Correspondents say the announcement was rushed forward, at a time when the CIA and the FBI are being heavily attacked for their failure to prevent the events of 11 September.
Department of Homeland Security
170,000 employees
Annual budget of $37bn
Resources and personnel to be drawn from 100 existing government agencies
"I ask the Congress to join me in creating a single permanent department with an overriding and urgent mission: securing the American homeland and protecting the American people.
"America is leading the civilised world in a titanic struggle against terror. Freedom and fear are at war - and freedom is winning."
One of the agencies criticised for those failures - the FBI - came under the spotlight on Thursday as its director and a whistleblower testified before the Senate about changes that needed to be made.
Mr Bush's reforms come after searing criticism that turf wars and poor communication helped to create a situation where there were maybe enough strands of information to predict the New York and Washington attacks, but no-one pieced them together.
"Based on everything I have seen, I do not believe anyone could have prevented the horror of the 11 September - yet we now know that thousands of trained killers are plotting to attack us - and this terrible knowledge requires us to act differently," Mr Bush said.
Proposals
The intelligence "clearing-house" of the new Cabinet-level department will:
Under the plans, the FBI and CIA will remain independent but will funnel information to analysts in the new department who can decide if various pieces of information add up to a threat that has to be addressed.
The new department will have a staff of 170,000 drawn from other agencies and an annual budget of $37 billion.
Plans welcomed
The proposals were received warmly by politicians who had been calling for change.
Senator Joe Lieberman said: "It shows real leadership to be willing to change direction, and that is what the president has done for the security of all Americans."
His colleague Robert Byrd was a little less enthusiastic: "I only say that it is about time, and I hope that it is not too late."
The new agency will be headed by the current director of the White House Office of Homeland Security, Tom Ridge, whose job was created in the immediate aftermath of 11 September.
Changes under way
FBI director Robert Mueller testified to the Senate Judiciary Committee that changes had already been made and that now, unlike before 11 September, he met each morning with CIA chief George Tenet to discuss intelligence issues.
But he admitted the need for a wholesale "top to bottom" review of the agency.
But cumbersome technology was partly responsible for the failure to pull together strands of intelligence and he said investment in improved computer systems was needed.
Agent's testimony
One of his agents, Coleen Rowley, also appeared before the committee.
She was called after she wrote a damning 13-page memo to Mr Mueller detailing mistakes made by the FBI before the 11 September attacks.
"We need to streamline the FBI bureaucracy in order to better combat terrorism," she said.
"The need for people at FBI headquarters who can connect the dots is painfully obvious."
In her memo Ms Rowley, an FBI agent for 22 years, said senior personnel put "roadblocks" in the way of Minneapolis staff trying to investigate Zacarias Moussaoui, now alleged to be the "20th hijacker".
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